Wednesday, November 28, 2007

The idea behind cyclical and non-cyclical stocks is simple. When money is tight, what can you do without or put off, and what do you really need? You may want a new car, but if your budget is very tight, it may have to wait. However, toothpastes, toilet paper, and electricity can’t wait.

Cyclical Stocks Cyclical stocks represent those items and services for consumers and businesses that they buy when confidence in the economy is high. Cyclical stocks follow an upward turn in the business cycle when businesses and consumers are spending money.

Cyclical stocks follow an upward turn in the business cycle when businesses and consumers are spending money.Automobile companies are classic cyclical stocks. When the economy is good and people are working, car sales do well. However, if there are layoffs and uncertainty or high interest rates, people may decide to hold on to their car another year.

Businesses expand during good times. They buy new equipment and build new facilities, so equipment sales and construction are cyclical stocks.

When the economy cools, businesses run down inventory, put off expansions, and delay purchases. Cyclical stocks such as steel manufacturing and sales suffer when business slows down. Some of the very good examples of cyclical industries are automobile, heavy machinery, steel, furniture, airlines, etc.

Non-Cyclical Stocks Non-cyclical stocks represent those items and services for consumers and businesses that they can’t put off no matter what the state of the economy. The stocks of companies producing these things are non-cyclical and are "defended" against the effects of economic downturn, providing great places to invest when the economic outlook is sour.

Two of the sectors, Consumer Staples and Utilities, are non-cyclical stocks and the rest are cyclical.

The classic example of non-cyclical stocks is utilities. Everyone from consumers to businesses needs water, gas, and electricity. When the economy is growing, these stocks tend to lag behind, however during economic downturns; their steady returns may look good.

Wednesday, November 14, 2007

What is Behavioral Finance?Peter Bernstein states that the evidence "reveals repeated patterns of irrationality, inconsistency, and incompetence in the ways human beings arrive at decisions and choices when faced with uncertainty."

Behavioral finance attempts to explain how and why emotions and cognitive errors influence investors and create stock market anomalies such as bubbles and crashes. But are human flaws consistent and predictable such that they can be: a) avoided and b) exploited for profit?

Why is Behavioral Finance Important?"Investing is not a game where the guy with the 160 IQ beats the guy with the 130 IQ…Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing."--Warren Buffett

Common Mental Mistakes1) Overconfidence2) Projecting the immediate past into the distant future3) Herd-like behavior (social proof), driven by a desire to be part of the crowd or an assumption that the crowd is omniscient4) Misunderstanding randomness; seeing patterns that don’t exist5) Commitment and consistency bias6) Fear of change, resulting in a strong bias for the status quo7) "Anchoring" on irrelevant data8) Excessive aversion to loss9) Using mental accounting to treat some money (such as gambling winnings or an unexpected bonus) differently than other money10) Allowing emotional connections to over-ride reason11) Fear of uncertainty12) Embracing certainty (however irrelevant)13) Overestimating the likelihood of certain events based on very memorable data or experiences (vividness bias)14) Becoming paralyzed by information overload15) Failing to act due to an abundance of attractive options16) Fear of making an incorrect decision and feeling stupid (regret aversion)17) Ignoring important data points and focusing excessively on less important ones; drawing conclusions from a limited sample size18) Reluctance to admit mistakes19) After finding out whether or not an event occurred, overestimating the degree to which one would have predicted the correct outcome (hindsight bias)20) Believing that one’s investment success is due to wisdom rather than a rising market, but failures are not one’s fault21) Failing to accurately assess one’s investment time horizon22) A tendency to seek only information that confirms one’s opinions or decisions23) Failing to recognize the large cumulative impact of small amounts over time24) Forgetting the powerful tendency of regression to the mean25) Confusing familiarity with knowledge

"Investment is most intelligent when it is most businesslike" - Ben Graham

"Investing is a strange business. It's the only one we know of where the more expensive the products get, the more customers want to buy them" - Anthony M Gallea

Warren Buffett Quotes:"I will tell you how to become rich. Be fearful when others are greedy. Be greedy when others are fearful.""I don't try to jump over seven-foot bars. I look around for one-foot bars that I can step over."

“It takes 20 years to build a reputation and five minutes to ruin it. If you think about that, you'll do things differently.”“Risk comes from not knowing what you're doing.”“Wide diversification is only required when investors do not understand what they are doing.”“Only when the tide goes out do you discover who's been swimming naked”“You only have to do a very few things right in your life so long as you don't do too many things wrong.”“If a business does well, the stock eventually follows.”“There seems to be some perverse human characteristic that likes to make easy things difficult.” “Our favourite holding period is forever.”“Rule No.1: Never lose money. Rule No.2: Never forget rule No.1.”“A public-opinion poll is no substitute for thought.”“It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.”“The business schools reward difficult complex behavior more than simple behavior, but simple behavior is more effective.”“Look at market fluctuations as your friend rather than your enemy; profit from folly rather than participate in it.”“Of the billionaires I have known, money just brings out the basic traits in them. If they were jerks before they had money, they are simply jerks with a billion dollars.”“I never attempt to make money on the stock market. I buy on the assumption that they could close the market the next day and not reopen it for five years.”“I always knew I was going to be rich. I don't think I ever doubted it for a minute.”“If past history was all there was to the game, the richest people would be librarians”“You do things when the opportunities come along. I've had periods in my life when I've had a bundle of ideas come along, and I've had long dry spells. If I get an idea next week, I'll do something. If not, I won't do a damn thing.”“When a management team with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact.”“We believe that according the name "investors" to institutions that trade actively is like calling someone who repeatedly engages in one-night stands a "romantic”“Only buy something that you'd be perfectly happy to hold if the market shut down for 10 years.”“I’d be a bum on the street with a tin cup if the markets were always efficient.”http://en.wikiquote.org/wiki/Warren_Buffett

Charles T. Munger "Read all the time""Be prepared, act promptly, in scale, on a few major opportunities.""It takes character to sit there with all that cash and do nothing. I didn't get to where I am by going after mediocre opportunities""Compound interest is the eighth wonder of the world" - Einstein "Never interrupt it unnecessarily" - Munger

Thursday, November 1, 2007

Investments based on advices/tips is tricky. We can get plenty of it from - Internet, brokers, friends, books.....

Few things to keep in mind about investment advices:

The advice may be wrong!!

Differences in investment style, the person who advised may have a different style of investment, stock may be volatile, and adviser may hold it through the price volatility.

The investment time horizon for the adviser and the investor may not be same. In most of the cases, investment time frame is mentioned in the advice itself, but investor need to hold it for that duration.

The way investor and adviserrespond to news or market fluctuations may be different and it can affect the outcome.

Chances of adviser acting not in the best interest of the investor.

Getting advice on investment principles and studying about it is good. But we need to be careful about advices on particular stocks. Even a good advice to buy a particular stock may not work the same way for all. Look at the advices as one source of information along with lots of other sources, but do own homework before investing. It's not adviser's money which is at risk!!